LAO Reveals Break in Revenue Neutrality Promise

In a response to Governor Brown’s May revision of California’s budget, the Legislative Analysts Office revealed that the tax incentives enacted in 2013 to replace the Enterprise Zone program have failed to live up to their promise.

“By providing a hiring tax credit and a state sales tax exception on innovative tools, the new law will allow Takeda California to pursue staffing levels and collaborations with local universities that we would not have been able to afford otherwise,” said Takeda California President and Chief Science Officer Dr. Keith Wilson.

“With the signing of today’s bills, California now has real economic development programs in place that create new jobs,” said California Labor Federation Executive Secretary-Treasurer Art Pulaski. “And not just any jobs. Good jobs, middle class jobs, jobs that build communities and rev up our engine of economic growth.”

“The Governor’s economic package signed into law today will be invaluable to enabling small and mid-size California life science companies to be more competitive in the global market,” said BIOCOM President and CEO Joe Panetta.

The new Initiative will be funded by redirecting approximately $750 million annually from the state’s outdated and ineffective Enterprise Zone program.

However, the LAO now explains:

In 2013, California acted to gradually eliminate, over time, its tax benefits for certain businesses in “enterprise zones,” a state economic development program our office had found to be expensive and ineffective.

As part of the 2013 enterprise zone elimination package, state leaders instituted new business tax benefits that were intended to be more effective ways of encouraging business investment and job creation. These new tax benefits included (1) a new exemption for certain manufacturing or research and development equipment from part of the sales tax, (2) a new credit (replacing a prior credit) to encourage hiring by certain businesses, and (3) a new incentive under which businesses would apply for a tax credit in exchange for certain hiring and investment decisions. (This latter incentive is now known as the California Competes tax credit program, which is administered by the Governor’s Office of Business and Economic Development and currently awards a certain amount of tax credits for these purposes each year.)

Estimates in analyses of the 2013 bills instituting these changes anticipated the revenue effects of these changes would be close to “revenue neutral” for the state, at least through 2016-17. These projections, derived from tax agency and administration estimates as of 2013, anticipated that the revenue losses from the new sales tax exemption, the new hiring credit, and the California Competes program would roughly offset revenue gains from the gradual elimination of enterprise zones and the prior jobs credit. Over time, we have been asked how accurate these initial estimates have proven to be.

According to the administration’s May 2017 estimates, summarized below, the tax changes from the enterprise zone elimination package have instead resulted in a net revenue gain of several hundred million dollars per year for the state’s General Fund. While estimated revenue gains from elimination of enterprise zones have remained essentially unchanged, state revenue losses from the new sales tax exemption and the new hiring credit are far below initial estimates in the bill analyses. (We discussed the sales tax exemption earlier this year.) Actual usage of credits allocated by California Competes has been slower than expected, but these seem likely to ramp up somewhat, so long as the program continues.

“…A new exemption for certain manufacturing or research and development equipment from part of the sales tax”

It’s interesting to note that Takeda California, whose president was quoted in the Governor’s press release, has not received the New Employment Credit nor the California Competes credit based on information published by the FTB and Cal-BIZ.